Reading market commentaries to see how wrong we all are from time to time can be entertaining. Let’s start by taking an excerpt from a leading investment expert, Bob Doll, Vice Chairman and Global Chief Investment Officer of Equities at BlackRock.
This year-end review was written in January 2008, at the precipice of one of the worst recessions in modern history. The review was also at the onset of one of the greatest bull runs in stocks.
The disruptive reverberations of the Great Recession are still being felt nearly nine years later by families, businesses, and investors around the world.
Here’s the quote from January 2008:
While we expect that credit woes will continue to stoke recessionary fears over the next several months, we believe we will narrowly escape a recession.
Mr. Doll goes on to state:
It’s a close call, but avoidance of a recession seems likely to us, which points to another year in which equity markets are likely to struggle, but should move higher given attractive valuations. Areas of the market where we see particularly good value include U.S. large caps (particularly multinationals), growth styles and emerging markets.
Admittedly, in hindsight, it was a challenge for all of us to recognize how endemic the economic problems were in our economy—and certainly how deep and painful the recession would be.
However, what predictive types may not understand is how many people, unfortunately, do follow their guidance. Investors often draw the conclusions that they hope to achieve with their financial futures based on predictions that absolutely nobody knows will be accurate.
What to Do?
Thankfully, the foundation of being a good investor lies not in predicting outcomes correctly. We can’t stress that point enough. In fact, being a good investor often means being brutally honest with ourselves.
Sounds simple right? How hard is it to accept the notion that we don’t know where the markets will end up tomorrow, next week, or next year? For some, it’s impossible because they make their livings off this denial. But for those of you who fear the unknown, take heart, because you’re in great company!
The fact is that nobody has ever known what the future holds. We’ve been in this business awhile and have read a lot of books, researched managers, and attended lectures by the sharpest, most well-informed investment minds in modern history.
In time, their efforts eventually point to one common theme, which is that nobody knows which way the markets will turn, or when, or by how much. You can still make a lot of money if you have patience and discipline, as well as a healthy dose of realism.
The best we can do is structure a well-thought-out portfolio and stick to it through the best of times and the worst of times. The “best we can do” can also yield fantastic results! Rebalancing your portfolio to keep it to an original target balance, whether it’s 95% stocks and 5% bonds, vice versa, or any portfolio in between, forces us to sell high and buy low.
It’s pretty simple, really. Sure, as professional investors, we add a bit here and there to boost our clients’ returns marginally and sustainably, but this focus lies far outside the predictive investing methods that are so alluring to so many. And the best part is that our results over time are just as good, if not better, than those of many highly sophisticated strategies.
A True Story
Let’s demonstrate this theme with a true story. Keep in mind that this scenario is played out fairly consistently:
Client 1 had little of what a person like Mr. Doll above would consider investment sophistication. Client 1 simply knew to invest in his 401(k) plan and hold a target of 70% stocks and 30% bonds. The portfolio grew over 30 years to several million. He would say things like “I didn’t really care most of the time what was going on in my 401(k). This stuff just kind of bored me, really.” This actually made me chuckle.
Client 2 had considerably more investment sophistication. He attended fancy investment seminars, read books, listened to financial talk radio, and dabbled in many investment theories, all sounding wise and well thought out at the time.
Whenever I spoke with Client 2, he could converse in the most sophisticated terms of investment parlance. Yet his returns were far worse than Client 1’s returns. How do I know this? Because they both contributed the maximum permissible 401(k) contributions for roughly the same amount of time—and at the same company! Yet Client 2’s 401(k) balance was far lower.
So, if they had the same inputs to their accounts, why wouldn’t Client 2 have massively outperformed Client 1? It’s simple. Client 1 had a better philosophy: Leave a simple, well-structured portfolio alone! Let the market earn you your returns, and don’t try to predict the future.
Predictions will lead us down a road we don’t want to go. If you don’t believe this, try this fun experiment:
- Write down where you think the markets (Dow, S&P, Nasdaq, emerging markets, etc.) will be in 12 months.
- Put your predictions in a sealed envelope, and hide the envelope in an out-of-the-way spot at home.
- Schedule a reminder in your smartphone telling you where the envelope is and to open it one year later.
If you do this year after year, you’ll find that you have years when you predict completely wrong and years when you may be close. The point here is that investors who use their predictions to structure their investment portfolio will eventually lose so much money when they predict wrongly that they will never catch up with the “Client 1 method.”